However, Mercer points out that accounting liability does
not include all costs associated with maintaining the plan. Since October 2013,
the cost of maintaining a DB plan continues to be approximately the same as the
cost of transferring liabilities to an insurer for the sample plan modeled for
Mercer’s U.S. Pension Buyout Index. The current environment allows plan
sponsors who have evaluated a risk transfer to execute under favorable
conditions, the consultant says.

During March, the index showed the average cost of
purchasing annuities from an insurer increased slightly from 108.4% to 108.6%
of the accounting liability. The economic cost of maintaining the liability
remained level, at 108.7% of the balance sheet liability.

The
index tracks the relationship between the accounting liability for retirees of
a hypothetical DB plan and two cost measures—the estimated cost of transferring
the pension liabilities to an insurance company (i.e., a buyout) and the
approximate total economic cost of retaining the obligations on the balance
sheet.

Mercer notes that research from the Society of Actuaries
revealing people are living longer than expected may result in actuaries soon
updating plan mortality assumptions, which would increase plan liabilities.
While no start date has been established yet for when these new life
expectancies are to be used, Mercer expects the Internal Revenue Service may
require plans to use the new tables to assess funding from 2016 onward, while auditors
may expect plan sponsors to reflect the new tables even earlier than that for
accounting purposes. The increase to plan liabilities is expected to be greater
than any increase seen in annuity prices, which Mercer believes will be another
compelling reason for plan sponsors to purchase annuities and transfer the
risk.

In addition, the annual per participant premiums for the
Pension Benefit Guaranty Corporation (PBGC) were recently increased significantly,
from $49 per participant in 2014 to $64 per participant in 2016, and increasing
with inflation thereafter, according to the index. This increase of more than
30% is a contributing factor to the increasing costs to plan sponsors of
maintaining their DB plan and is a large factor in many plan sponsors’
decisions to transfer liability (see "PBGC
Premium Hikes Shake Up Buyout Landscape").

Mercer notes that the current economic environment, combined
with the increase in PBGC premiums and adoption of the new mortality tables on
the horizon, makes 2014 an attractive time for DB plan sponsors to consider an
annuity buyout as an effective risk management tool.

According
to Mercer, DB plan sponsors considering a buyout in the future should review
their plan’s investment strategy and consider increasing their allocation to
liability hedging assets, either immediately, given recent improvements in
funded status, or over time as the funded status improves. This can reduce the
likelihood of the funded status decreasing again, leading to unexpected
additional cash being required to purchase annuities at a later stage.